Tax surcharge meant for wealthy becomes middle-class problem

WASHINGTON -- An obscure tax intended to prevent wealthy individuals from dodging their income taxes will hit one-third of taxpayers by the end of the decade, private researchers report.

By 2010, many taxpayers who consider themselves average middle-class families will pay the tax. It will hit 97 percent of married couples, with 2 or more children, who earn $75,000 to $100,000.

Researcher Leonard Burman, co-director of the nonpartisan Tax Policy Center, said Monday that repeal is the best way to prevent the tax from plaguing the middle class.

"But it would cost a lot," he said, estimating a nearly $1.5 trillion drain on the federal government through 2013 if the tax were repealed this year. The Tax Policy Center is a joint venture of the Urban Institute and the Brookings Institution.

The tax, called the alternative minimum tax, started in 1970 after lawmakers discovered that a handful of high-income households had used tax shelters to avoid paying any income taxes.

It now imposes a complex accounting requirement on many taxpayers, forcing some to compute their taxes twice, once under standard procedures and again under the alternative minimum tax.

The Internal Revenue Service's taxpayer advocate identified the tax as one of the most complex parts of the code and has urged repeal.

As the problem gets bigger, it gets more attention.

"The good news is that as the reach of the alternative minimum tax expands to encompass ever more taxpayers, the political benefits of seeking out a solution will expand as well," Burman said.

Congress stopped the tax from encroaching on additional taxpayers in the $350 billion economic package enacted in May.

Although lawmakers have blunted its effect for a few years, the tax will continue to effect more middle class taxpayers because it is not indexed for inflation. That means it will strike increasingly more taxpayers as their incomes rise.

The study said the tax will become an increasing burden on the middle class because many deductions cannot be used when computing the alternative minimum tax. Families with children and those living in high-tax states will be particularly hard hit because the minimum tax calculations do not allow exemptions for children or deductions for state taxes.

The alternative minimum tax will amount to a substantial surcharge, an average of $3,750, by 2010.

The researchers also concluded the tax no longer serves its original purpose and does little to block individuals from using tax shelters.

In the late 1960s, when lawmakers identified individual tax shelters, many high-income individuals converted their earned income, taxed at high rates, into capital gains, taxed at a lower rates.

Over time, lawmakers changed the alternative minimum tax computations to exclude capital gains. Congress acted in May to reduce the top capital gains rate to 15 percent, and Burman said the reduction could create more tax shelters.

"I wouldn't be at all surprised if tax sheltering increased in the years to come, and the AMT wouldn't do anything about it," he said.